Non compete agreement in mergers and acquisitions

Para ver la versión en castellano de esta entrada: este Link.

Grand Canal from Palazzo Flangini - Canaletto

The current entry remarks some arguments contained in two judgments from two Provincial Courts of Spain that often provide relevant judgments on corporate law. In this case, both judgments resolve regarding the vendor non compete agreement in favor of the buyer, due to a company’s sale and purchase. The first one is the Judgment 164/2008 of the Barcelona Provincial Court (Secc. 15) and the second one is the Judgment 350/2015 of the Madrid Provincial Court (Secc. 28).

First, it should be noted that in the case judged by the Barcelona Court the acquisition involves all the shares of the company, while in the case judged in Madrid the acquisition involves just a relevant percentage. The arguments are the same as both transactions purpose is to acquire the control over the company.

In the case resolved by Judgment 164/2008, the non compete clause included in the shares purchase agreement (SPA) establishes the following: “(the majority shareholders and sellers) are committed during a period of five years from the closing date, not to develop directly or indirectly through any company (…) any activity in the field in which the company operates, and/or that could imply in any way competition with the activity undertaken by the buyer, (…) unless such activity is developed by Mr. Octavio and Mr. Angel (the majority shareholders and sellers) with express written consent of the buyer.”.

The issue when we face such a clause is related to its validity, despite the fact that the obligation included effectively restraints free competition. Furthermore, the possibility to moderate the penalty based on article 1154 of the Spanish Civil Code (CC) is also analyzed.

Despite the signature and execution of the clause above seen, the vendors carried out competitive practices before the termination of the five years period, without prior buyer’s permission.

In first instance the judge ruled the validity of the clause, but reduced the compensation resulting from the penalty included in the non compete clause of the SPA. This reduction was applied based on article 1154 CC, because the judge considered the damage was also minor as a result of the breach of contract during the second year.

On appeal, the Barcelona Provincial Court also accepts the validity of the clause. In order to explain this decision Case Foodservice-Mercat resolved by the Spanish Competition Tribunal (Tribunal de Defensa de la Competencia) is recalled. In this case, the Tribunal said that such kind of agreements fall within the prohibition under pursuant to article 1 of the Spanish Act on Protection of Competition. However, this clause may be justified to protect the buyer. This is because the buyer is paying a price to obtain the control of the company, and the goodwill is an essential part of the company. Taking into account that the seller is in a privileged position to keep or bring with him the goodwill (customers) after the transaction, the existence of this risk should be managed.

It is therefore reasonable to permit a non compete clause, provided that the restriction is limited on time, territory and activity strictly required to facilitate the buyer the consolidation of the customers and the accomplishment of the expectations generated with the transaction. Remember that the buyer is paying a price to acquire the goodwill/customers.

Non compete agreements in acquisitions of companies have no explicit regulation, almost in Spain and EU laws. Therefore, it is often applied the maximum period of two years for non compete clauses, as regulated in agency agreements. Furthermore, it is also common to agree a maximum period of three years, due to arguments of the European Commission in its decision of September 1, 2000 (Case Clayton Dubilier & Rise/Italtel). However, the European Commission in Case Volvo/Renault VI, and the European Court of Justice (ECJ) in its Judgment of July 11, 1985 (Case Nutricia), the possibility to agree non compete clauses of five and even ten years, due to extraordinary reasons, is expressly accepted.

The Barcelona Court also says that in case of no statement included in the SPA regarding the breach of the non compete clause during the period agreed, the default is not partial but total. Therefore, to moderate the penalty based on article 1154 CC does not apply. In accordance with this, the Barcelona Provincial Court orders to pay the entire amount of the penalty, in opposition to the Judgment ruled in first instance.

In Judgment ruled by the Madrid Provincial Court we observe that its arguments follow the same of the Barcelona Provincial Court. However, we may remark that some arguments are added in matters related to the transaction of a package of shares, the comparison with the regulation of the agency agreements and, in special, the implications to the right of the sellers to work.

In case resolved by the Madrid Provincial Court we find a very relevant difference, that is related to the duration of the non compete clause, as this is fixed in ten years. Therefore, the judge has to decide if the existence of extraordinary reasons justifies a period beyond three years. In relation to this issue, we find the following reasoning of the judge:

“Preventing the defendant (seller) to carry out its professional activity, by itself or through a company, for a period of ten years referred to in the contract, would mean an unacceptable restriction of freedom to work and recognized in article 35 of the Spanish Constitution (…), therefore this agreement violates public order, resulting in the nullity of the clause or, at least, the period exceeding two years.”.

In consequence, the Madrid takes into account not only the regulations on agency agreements (two years limit) but also labor law and, in particular article 4.1 of the Workers’ Statute and article 8.3 of the Royal Decree 1382/1985, on senior management.

In conclusion, in shares/stock purchase agreements, either acquiring a package of control or all the shares of the company, the non compete clause should establish a maximum duration of two years in general. However, this period may be extended provided that extraordinary reasons apply with the purpose to protect the buyer or, in other words, to protect the contract’s purpose. Furthermore, when a non compete clause may have effects on the right to work of the seller, the duration of the restriction need to respect this right.